Employee Stock Ownership Plans as a Community Asset-Building Strategy

Concept

The Northland Institute believes that Employee Stock Ownership Plans (ESOPs) have significant potential to be a valuable community asset-building tool by extending business ownership to workers and families that typically are asset-poor (even when employed), and by rooting businesses more firmly in their communities. Employee ownership is especially significant for rural people and communities, since it is typically more difficult to attract and retain quality employment opportunities in rural areas. The tendency in our market economy is for economic activity to gravitate toward major metropolitan areas. The addition of a new kind of financing tool to the ESOP arsenal could make a dramatic difference in the future use of ESOPs for the long-term economic growth and stability of rural Minnesota communities.

Background

Fundamentally, an ESOP is an ownership structure in which employees gradually acquire partial or full ownership of their company. ESOPs typically are established for one (or both) of two reasons: first, to facilitate the buyout of a business owner (often the sole proprietor of a closely-held corporation); and, second, when company owners wish to reward employees with the opportunity to acquire, as part of their compensation, partial ownership in their company. In most cases, all full-time employees age 21 and older participate in their ESOP.

ESOPs are governed by ERISA (the Employee Retirement Income Security Act) and were authorized by Congress in 1974. According to The National Center for Employee Ownership, there are about 11,500 ESOPs in the U.S. serving approximately 8.5 million Americans.

Asset-Building - A Greater Minnesota Example

The Antioch Company of St. Cloud, Minnesota is an example of the asset-building potential of an ESOP.  Antioch is an employee-owned company based in Yellow Springs, Ohio.  In 1992, they bought Holes-Webway, a bankrupt St. Cloud manufacturing firm.  Antioch revived the company and invested heavily in facilities and equipment.  They also retained all of the former Holes-Webway employees and made significant investments in employee training.  Antioch and its St.Cloud-based marketing subsidiary, Creative Memories, have seen tremendous growth in ten years.

The Antioch ESOP was a part of their employee benefit package. Now, the company's modestly paid production and distribution workers based in St. Cloud also share in the ESOP.  Today, the value of the shares owned by Antioch's 250 St. Cloud employees is more than $8 million.

Through the benefits of employee ownership, workers at all economic levels that typically do not have the same wealth creation capability as highly compensated management can acquire significant personal assets. Further, the company's ESOP-funding obligation more firmly anchors the company in St. Cloud.  (If Antioch were to close their St. Cloud plant and/or move their facility to any other location, they would have to buy out the shares of all laid-off employee-owners. Instead, the company is in the process of making a significant expansion locally.)

The Antioch story may not be typical of ESOPs due to its scale, scope, and success, but it does illustrate the potential for community and employee asset-building.

The Opportunity

Northland Institute is in the process of exploring the use of ESOPs as an overt community development and employee asset-building tool. One frequent obstacle to the use of an ESOP is the availability of the right kind of financing - the capital necessary to finance the purchase of going business concerns that will allow the new employee owners to gradually acquire ownership as the ESOP loan is repaid. A new source of flexible capital for financing ESOP transactions in rural Minnesota communities would make this option available to more companies, and subsequently, lead to more secure jobs and greater wealth among employees at all income levels.

One possible scenario: The sole proprietor of a medium-sized manufacturing company in a Greater Minnesota community wishes to retire, but has no family members interested in carrying on in the business.  He also is unable to finance the sale of the company, which constitutes the bulk of his net worth, through conventional lending sources. The business is profitable and has a solid base of contract work for large manufacturers, but does not produce extraordinary profits.  The most likely purchaser is one of several out-of-state competitors.  An absentee owner will be less likely to be a strong part of the community - charitable giver, Chamber of Commerce member, volunteer -- and less inclined to settle for a modest rate of return.  There will be fewer well-paid jobs in town because much of the corporate infrastructure will move to the new parent company's home base. Subsequently, the local Minnesota plant will be at greater risk of closure and disinvestment.

An ESOP would enable employees to keep their jobs and acquire new personal assets (wealth), while allowing the community to retain a healthy, still profitable, locally owned company.  The obstacles today for selling the company to an ESOP include the availability and cost of capital (commonly, as in our scenario, the rate of profit is modest, though secure), the unwillingness of the seller to provide long-term financing, employees' perceptions of risk, and the complexities of ESOP law and regulations.

Through the establishment of an ESOP financing pool, investors seeking to promote community economic health, those interested in employee ownership, and even local economic development groups could support the sale of local businesses to employees and help keep these companies viable and operating locally.

Project Goals

A couple of national groups are working to simplify ESOPs in order to make this tool more usable and accessible for smaller companies. However, to the best of our knowledge, no other organization is attempting to increase the supply of rural capital to finance ESOP transactions, nor shares Northland Institute's belief that the establishment of more ESOPs throughout rural Minnesota would be a valuable community asset-building tool that would improve the long-term economic health of rural areas.

The primary goals of the Institute's Rural ESOP research and development project are to:

• Design an investment pool that would provide patient, flexible capital to support the creation of ESOPs at the critical stage of a business transition in rural Minnesota communities;
  
• Identify strategies to refocus existing government and charitable community development funding to provide companies with an incentive to create ESOPs for their employees.
  
• Determine the needs and opportunities for rural education and training seminars and conferences to better inform local businesses and their business service providers (i.e. attorneys, accountants, financial planners, and other business consultants) about the benefits of establishing an ESOP.

Conclusion

The first phase of this research and development project will be completed in September 2003. Public comments concerning this effort are welcome. Please contact Scott Martin at the Northland Institute at (952) 541-9674.

ESOP Advisory Council

The following individuals have been personally selected to provide valuable insight and direction on the progress of the ESOP project:

John Babcock is an attorney and CPA who has been involved in the establishment of a number of ESOPs.  He is knowledgeable about the legal aspects of creating an ESOP and the necessary management structures required to operate one successfully.  John is also very active in the St. Cloud community and is very enthusiastic about the community benefit potential of ESOPs.

Rick Bauerly is a principal of a community venture fund based in St. Cloud.  The goal of the fund is to provide a finance mechanism for closely held companies that are being sold - typically due to generational transition - thereby keeping ownership local.  ESOPs are an appealing option for the sellers.  The fund is a potential source of equity financing for new ESOPs in Greater Minnesota.

Gary Marsden is the President and CEO of a business services company with 185 employees that established an ESOP in 1989, and is currently one of the few 100% ESOP-owned companies in the state.  Gary is passionate about the tremendous productivity gains that ESOPs can bring to a company.  Employees have a new incentive to really understand and care about the company and management has a new responsibility to share knowledge with the employees, and not to manage selfishly.  Gary is a very dynamic and well-connected business leader- a former Minnesota Chamber of Commerce Chair, among other positions.  He believes that education about ESOPs is very important in order to successfully increase the number of ESOP-owned companies in Minnesota.

Mark Phillips is a principal of Northeast Ventures and President of Iron Range Ventures, which are both community development venture capital funds serving northeastern Minnesota. Both funds are mission-driven organizations focused on job creation and entrepreneurial business development. They are very interested in promoting the ESOP ownership model among the companies they are invested in as a means of creating employee wealth and encouraging long-term community stability through local business ownership.

Jack Ryan and Rick Kasner are business partners in a firm that provides financial advice to companies undergoing ownership transition. They specialize in estate planning, business succession planning, employee benefit plan administration, and the financing of ownership conversions. Both have numerous business relationships throughout northeastern Minnesota.

Paul Halverson is a business valuation expert with significant experience in analyzing the feasibility of ESOPs for companies throughout Minnesota. He has broad knowledge of the potential market for new ESOPs in Minnesota and a thorough understanding of the barriers and challenges that face business owners who are contemplating the sale of their businesses to an ESOP.

Doug Holzkamp, as Vice President of the trust department at Bremer, is directly involved in the establishment and administration of ESOP trusts. He also provides business succession planning advice and administers employee pension plans and profit sharing plans for numerous businesses. Since he is also responsible for marketing Bremer's services to new client prospects, Doug understands the potential for the growth in the ESOP market, especially in the rural areas served by the ESOP-owned Bremer banks throughout Greater Minnesota.

Greg Hohlen is Vice President and Senior Loan Officer at Bremer Bank, specializing in SBA guaranteed business loans. Prior to joining the banking industry several years ago, Greg was an economic developer serving the Mille Lacs Lake community. Greg believes strongly in the concept of linking employee ownership with community economic development as a means of stabilizing local economies and building individual wealth among workers at all income levels.